New advances in dynamic ad insertion for video-on-demand (VOD) services will be a key driver of the $6 billion in VOD revenue awaiting U.S. multichannel service providers over the next five years, according to research released by SNL Kagan.

Considering that 95% of all VOD content is delivered for free, VOD-based channels are also looking for other means to increase their average revenue per user. As on-demand services gain in popularity, more cable and telco service providers will look toward dynamic ad insertion to bolster profits.

“The industry is certainly still in the early stages of formulating their approach to on-demand advertising,” said Ian Olgeirson, senior analyst for SNL Kagan. “We are seeing that there is a critical mass of viewing that creates this opportunity. We’ve got a lot of people spending a lot of time with on-demand content, and the cable operators and telcos need a way to monetize that…That critical mass coupled by the need to figure out the business model for on-demand creates the advertising opportunity.”

To make audience fragmentation work in their favor, operators are looking toward enabling ads to be inserted into content as the VOD session is initiated and, eventually, to match them with viewers using demographic information. The hope is that users won’t mind the ad intrusion as long as it relates to their lifestyle and interests and that channels will receive backing from interested advertisers.

For Motorola, the on-demand market is one that Conrad Klemson, director of engineering for Motorola’s on-demand video group, sees as having enormous potential – the extent of which the industry is just beginning to realize.

“If you look at the state of VOD today, across North America, we’ll probably have around 2 billion VOD views in calendar year 2007,” Klemson said. “By and large, with a few exceptions, there is almost no advertising in any of those VOD views. It represents a huge untapped market.”

As part of its Connected Homes solution, Motorola offers on-demand ad insertion to targeted groups of viewers or individual set-top boxes. Aided by the April acquisition of digital video processing vendor Terayon, consumers have the option of paying for on-demand content per-use or viewing it free with ads specifically targeted toward them. The ads can either be delivered as bumpers before and after the content or as dynamic playlists within a particular program or in between a series of smaller pieces of content.

Klemson categorized Motorola’s on-demand ad offering as in the lab trial phase. While the core pieces of the technology are there, the company is still working with its MSO partners to create an end-to-end solution. That being said, Motorola expects the market to take off as soon as next year.

“[On-demand advertising] is going to be the buzz word of 2008,” Klemson said. “All our major customers have planned to begin market trials in 2008.”

As most operators are just beginning dynamic ad insertion trials, SNL Kagan’s Olgeirson agreed that telcos largely are not concentrating on it quite yet. That goes for cable operators as well, with at least one exception. Sunflower Broadband, a small independent provider based in Lawrence, Kansas, has been doing dynamic local ad insertion for the past year. Due in large part to its size, the company has seen notable success among its 55,000 subscribers, Olgeirson said.

“[Sunflower has] run into an area where the demand exceeds the supply in terms of ad spots, so I think that that illustrates that they’ve had good success,” he said. “They can get away with some things that bigger operators would have more difficulty doing. Because they are small, they can fly under the radar. They are also not talking about huge volumes, so they can have a more personalized approach.”

Olgeirson added that Sunflower has the luxury to adapt very quickly, whereas a larger operator with multiple systems across multiple markets needs standards and a plan of action in place from the start. On the telco side, he predicted that AT&T is best poised to enter the on-demand ad market with success

“AT&T’s U-Verse IPTV should be in the best position to capitalize on that in the near term, but there is a lack of scale,” he said. “They are going to face the same issues as the cable operators in terms of designing, buying and managing national ad campaigns.”